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INVESTING IN Asian corporate debt

August 2021

Breadth, stability and quality: Asian corporate bonds

Asia's corporate bond market has become a strategic asset class that offers decent levels of income. Crucially, it is also predominantly investment grade.

The negative-yielding bond was supposed to be a temporary phenomenon. But seven years after they first began to emerge across the euro zone, some USD16 trillion of global fixed income securities continue to trade at sub-zero yields. That presents investors with a problem. Income-generating assets may be in short supply but they remain essential elements of a diversified portfolio. One fix is simply to allocate more capital to lower-rated bonds. Yet that route is not be open to all. Non-investment grade bonds’ yields might be higher, but so too is their volatility.

Moreover, many investors face regulatory limits on their holdings of high yield debt. Perhaps a more practical alternative solution comes in the form of Asian corporate bonds denominated in US dollars. There are plenty of factors to commend it as a strategic holding. To begin with, there's its heft. The asset class has grown rapidly and is now home to a wide range of issuers operating across every major industry. More importantly, it is a predominantly investment grade market and also offers a substantial yield pick-up over similarly-rated issuers based in developed markets. In other words the Asian corporate bond market is both too big and too valuable to ignore.

Heft and breadth

The dollar-denominated corporate bond market is expanding fast in Asia, and is home to almost USD850 billion of tradeable securities.And as it gains critical mass, it is becoming more diverse, featuring issuers from a wide range of industry sectors, much like its counterparts in the developed world. A marked change in corporations’ borrowing habits has contributed to its growth.

Banks were once the primary source of funding for Asian companies. But that proved problematic. Banks borrowed short-term in foreign currency and lent long-term in domestic currency – a mismatch in maturity and currency that left domestic banking vulnerable to sudden stops in foreign financing.

Alert to that risk, Asian governments have delivered reforms to develop domestic bond markets, These efforts, which are aimed at improving market infrastructure, widening the domestic investor base and enhancing investor protection, include:

  • Introducing mutual funds and individual savings accounts;
  • Lifting restrictions to foreign investors;
  • Introducing asset-backed securities and mark-to-market system;
  • Establishing inter-dealer brokers to act as intermediaries;
  • Removing the limit on corporate bond issuance amounts;
  • Creating new exchanges and improving corporate governance and disclosure.

Such measures are paying off. Bonds are becoming a more popular source of funding for Asia-based firms. The total amount raised in corporate bonds per year rose to 4.5 per cent of GDP in 2008-2017 from 1.6 per cent in 1990-98, while the share of corporate bonds in total corporate financing has increased at least ten-fold in the 10 years to 2015 from less than 1 per cent.2

The expansion looks set to continue. Asian businesses’ need for capital will grow in the coming years as the region’s economies forge closer trade links and invest heavily to build capabilities in technology, manufacturing, agriculture and natural resources.

Corporate bonds, then, are sure to play a more prominent role in the region’s economic development. The asset class does not just offer an attractive avenue for local companies to access funds; it can also act as a crucial backstop by substituting bank loans or equity financing should domestic lending conditions tighten.

Fig. 1 - Higher quality, higher yield

Yield to maturity, %

Bond yields and ratings compared

Source: Bloomberg, JP Morgan. Barclays Bloomberg Global Aggregate and US Aggregate sub indices. JP Morgan EMBI Global Diversified, CEMBI Broad Diversified, JACI Corporate Index as of 31.07.2021.

Fundamentals to the fore

But greater market breadth and depth aren’t the asset class’s only attractions for non-domestic investors. Its fundamentals demand closer attention, too.

To begin with, and despite its expansion, the quality of issuers has remained high. The asset class is dominated by top-ranked investment grade bonds, which make up a hefty 70 per cent of the market. Then there’s yield. At a time when more than USD16 trillion of bonds globally offer negative yields, Asian investment grade credit stands out for the substantial yield pick-up it offers over benchmark US government bonds. It also trades at a higher yield than US speculative grade debt. (see Fig. 1).

Fig. 2 - A line of defence: Asia corporate bonds hold up well during bouts of turbulence

Peak to trough loss, by asset class, %

Peak to trough performance

Source: Chinabond, JP Morgan. EU sovereign debt crisis (Aug-Nov 2011), Taper Tantrum (May 8 – end-2013), CNY devaluation (Aug 10, 2015), Covid-19 (Feb 21 – April 15, 2020); data taken from following indices JP Morgan. Barclays Bloomberg Global Aggregate and US Aggregate sub indices. JP Morgan EMBI Global Diversified, CEMBI Broad Diversified, JACI Corporate Index. All returns in USD.

The combination of superior creditworthiness and higher yields has helped turn the asset class into one of the most defensive fixed income investments in emerging markets. Indeed, during each of the major market corrections that have occurred since the 2008 financial crisis, up to and including the Covid pandemic, Asian corporate bonds have held up well compared to most other emerging market fixed income asset classes (see Fig. 2 and Fig. 3).
Fig. 3 - Solid return without the volatility

Annualised return and volatility,  by bond asset class, % 

Bond returns and volatility

Source: Bloomberg, data taken over period 31.12.2009-30.06.2021 and from following indices JP Morgan. Barclays Bloomberg Global Aggregate and US Aggregate sub indices. JP Morgan EMBI Global Diversified, CEMBI Broad Diversified, JACI Corporate Index. All returns in USD. 

There are good reasons to believe this will continue to be the case.

Prudent cash management. Asian companies tend to have nearly twice as much cash on their balance sheets and lower net leverage compared with their developed market peers. Investment grade Asian corporate issuers have, according to JP Morgan, a net leverage ratio of 1.4 while their cash holdings are equal to 42 per cent of their total borrowings. That compares favourably to US investment grade issuers, for which the respective figures are 2.4 and 24 per cent.

Low exposure to commodities. Asia’s bond market is not especially sensitive to commodity prices, which can be extremely volatile. This is particularly true for corporate debt, which has a lower proportion of issuers from the oil, gas, metals and mining industries than the bond markets of other regions but increasingly features companies from dynamic sectors such as renewables and telecoms.3

Home bias. The Asian corporate bond market benefits from a large and stable domestic investor base, which represent around 80 per cent of all investors. This group of primarily asset managers and institutional investors tends to have a longer time horizon and a greater tolerance for currency fluctuations, which helps reduce the overall volatility of the asset class. For example, in Korea, the combined holdings of pension funds and insurance companies account for nearly half of the corporate bond market.4

Income at an affordable price

A market that is becoming deeper and more liquid, Asian credit should represent an attractive opportunity for international investors keen to diversity their fixed income portfolio and participate in a long-term transformation of Asia’s economies.